Bond ETFs rallied this year as rates plunged back to record lows, but fixed-income investors shouldn’t bet on the rally to continue.
Among the best bond ETF performers, the iShares 20+ Year Treasury Bond ETF (TLT) gained 17.7% year-to-date. Meanwhile, the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) rose 15.2%.
U.S. government debt returned 7.8% this year through Thursday after price appreciation and interest payments, compared to the 2.2% average for the previous decade, the Wall Street Journal reports.
Corporate bonds strengthened 13% this year through Thursday, or more than twice the 6.1% average gain for the period since 2009. High-yield debt advanced 11%, or roughly matching its 12% annual average for the same period.
After this year’s rally, some are worried that bond prices have risen so much that there is little left to gain. Yields on benchmark 10-year Treasury notes now stood around 1.7% or 0.4 percentage points from its all-time lows after a combination of Federal Reserve interest rate cuts and surge in safe-haven demand.
Meanwhile, the extra yield investors now demand to hold both investment- and speculative-grade corporate debt relative to Treasuries stand near multi-year lows.
If fixed-income investors are looking for further gains, the economy will probably have to show new signs of deceleration, which could weigh on corporate and junk bonds, or riskier assets that tend to sell-off in times of stress.
“This is the quandary for taxable [bond]investors like ourselves,” Bryce Doty, a bond manager at Sit Investments, told the WSJ. “I’ve been telling my customers this just isn’t sustainable.”
“You can’t look at the market and say, ooh, this is a good value,” Nancy Davis, chief investment officer at Quadratic Capital Management and manager of the Quadratic Interest Rate Volatility and Inflation Hedge ETF, told the WSJ.
On the other hand, a rebound in growth that boosts corporate bonds would likely pressure gains in Treasuries as investors turn to riskier assets and dump safe-haven government debt.
“We’ve had such strong performance this year, you have to temper expectations about what future returns will be,” Kathy Jones, chief fixed-income strategist at the Schwab Center for Financial Research, told the WSJ.
For more information on the fixed-income markets, visit our bond ETFs category.